A Health Savings Account, or HSA for short, is a fantastic vehicle to pay for out-of-pocket qualified medical expenses which insurance does not cover in-part or in-full. It effectively allows you to get a tax deduction for nearly all of your unreimbursed expenses whether or not you itemize deductions. It also works great for those who itemize, but do not have enough medical expenses to get over the 7.5 percent or 10 percent (depending on your age) of adjusted income threshold before those deductions are counted. Many people assume they are receiving a tax benefit for these expenses when they are not. Simply look at your Schedule A, line 4. If it says $0, or if you do not even have a Schedule A, you are not benefitting from your itemized medical deductions. Even if you have a number there, line three will show you how much you are getting zero benefit from due to the threshold.

How do I Qualify and What Kind of Account Is It?

In order to qualify for an HSA, you must have a “high deductible” health insurance plan. For 2015, this means you have to have a minimum annual deductible of $1,300 for self-only coverage, or $2,600 for family coverage (or approximately the cost of breathing the air in a hospital lobby). Your plan must also have a maximum annual out-of-pocket limit of $6,450 for self-only coverage or $12,900 for family coverage. If you meet these requirements, you are eligible to set up an HSA account for yourself.

An HSA account is kind of like having a checking account just for qualified medical expenses, but is shares characteristics with an IRA account. A lot of people think the accounts are married to the health insurance providers, but they are not. Lots of banks and investment companies offer them. The account is a custodial account held for your benefit, and you get to choose the company that is the custodian, and you can move the money from one custodian to another, just as you could move your IRA from Fidelity to Vanguard, for instance. You often get a checkbook and/or a debit card. The custodian follows certain rules laid out by the IRS, and reports to the IRS at the end of each year the total contributions to and distributions from your account. The custodian is not responsible, however, for verifying that your expenses are qualified medical expenses, as that responsibility falls to you.

If you have health insurance through an employer and the plan qualifies, often your employer and its health insurance representative are instrumental in getting this account established, and they will select an initial custodian. Many employers will even contribute a monthly amount to your HSA account since the high deductible aspect often saves the employer money on the premiums. But even if your employer does not set an HSA up, you can do it. And as long as your health insurance plan qualifies, you can contribute to it.

How Do I Put Money Into the HSA?

Anyone is actually allowed to contribute to your HSA account (if you should be so lucky!), but there is a total contribution limit of $3,350 per year for self-only plans, and $6,650 for family plans in 2015. And you get an above-the-line tax deduction for the amount put into the account each year. Unlike IRAs, there are not even any income phaseouts that would prevent you from getting the tax deduction if you are a high-income earner. If your employer does not contribute enough to max out the contribution limit, you can always write a check to the account for the difference. You even have until April 15 (18 this year) to make the contribution for the prior year (similar to an IRA). If you are over 55 years old (IRAs are 50), you can make an additional $1,000 contribution each year.

If you are enrolled in Medicare or are being claimed as a dependent on someone else’s return, you cannot contribute to an HSA. In years where you change from self-only coverage to family coverage, or if you get married, or go through a divorce, stop insurance, start insurance, etc. be aware that there are special rules and limitations on contributions during those years, and you could subject yourself to a penalty if handled incorrectly. If you find that you have overcontributed for any reason, you generally have until the extended due date of your tax returns to get the money out without penalty. You do have to take out any earnings it generated as well, and those would be taxable in the year you physically take the money out of the account.

Can I Transfer Money Into My HSA from an IRA?

If you are desperate to get some additional money into your HSA, you can make a once in a lifetime transfer from your Traditional or Roth IRA to the HSA via a trustee to trustee transfer. However, it is still limited to the annual contribution cap, and it would be reduced by any other contributions you made to the account during the year! So it has very limited usefulness. If you were going to do that, your first choice would almost inevitably be the traditional IRA since the Roth IRA is already a tax-free account.

What/Who Can I Spend the Money On?

All medical expenses that would normally qualify for a deduction on Schedule A, would be a qualified HSA distribution, except for insurance. Generally, you cannot pay your health, vision, dental premiums, etc. from your HSA. Exceptions to this which you could pay from your HSA include long-term care insurance for the HSA account holder (subject to normal limits on long-term care insurance deductions found in the Schedule A instructions), COBRA insurance premiums for you, your spouse, or your dependents, or health insurance paid while you, your spouse, or dependents are receiving federal or state unemployment compensation. Also, if you are 65 or older, you can pay your Medicare and other health insurance premiums (except supplemental Medicare policy premiums) from your HSA.

For the bulk of the qualified medical expenses, you can deduct them for yourself, your spouse, your dependents, or for someone you could have claimed as a dependent except that they were disqualified simply because they filed a joint return, had gross income over $4,000, or were married filing jointly and one of the spouses could have been claimed as a dependent. If you are divorced with children, you can also pay for your children’s medical expenses whether or not you are a custodial parent or claim a dependency exemption, as long as least one of you qualifies to claim the dependency exemption.

If you take money out of the account and do not use it for medical expenses, it will be taxable income, and you will hit a 20 percent tax penalty as well. When you reach age 65, however, you can take the money out and use it for any purpose with no penalty (as opposed to 59.5 for most IRA owners). So in a lot of ways, should you never use it for medical expenses, it acts like another IRA.

Also for people that become permanently disabled, they can escape the 20 percent penalty tax even if used for nonqualified expenses.

In two weeks we will conclude the discussion on HSA accounts and discuss topics such as whether or not you have to pay qualified medical expenses directly from your HSA, strategy for large bills that exceed your HSA balance, having separate accounts for spouses, what happens to the account when you pass away, pitfalls to avoid, and a discussion of the Form 8889 itself.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.

If you have traditional or Roth IRAs, you owe it to yourself to understand what is meant by having “basis in your IRA.” This is especially important for people that have switched tax preparers over the years or prepared returns themselves, as they may not have transferred or tracked the amounts properly from year-to-year, or preparer-to-preparer. Failure to understand this concept could result in oversights that cost you thousands or tens of thousands of dollars in tax when you start withdrawing and using the money from those accounts.

Having basis in your IRA means that you have made a contribution to your IRA at some point over the years for which you did not receive a tax deduction when you made the contribution. Since you did not get a tax deduction when you contributed the money, you should not have to pay tax when you withdraw the money. Roth contributions, by nature, are those for which you receive no tax deduction when you put the money in, so all contributions create basis. With traditional IRAs, you create basis when contributing if your income is too high and you are therefore disallowed from taking the tax deduction. Having high income would not prohibit you from making the contribution to the account, but you would just not be allowed to take the tax deduction on the tax returns.

If you are unfamiliar with the related calculations and forms and do not review them carefully or discuss them with your return preparer (or just plain have no interest in doing so!), you could easily assume you are getting a deduction when you are not. Financial advisors generally have no idea if you have basis in your IRAs because they do not typically obtain copies of your tax returns and verify the deductions each year – it is just not part of their job description. Basis to them generally means, what did you pay for the stock, bond, or mutual fund (a different concept of basis relevant for regular brokerage accounts).

And you do not really need a lot of income to be phased out from the deduction; it is not just a problem for the rich. For tax year 2015, people filing single or head of household that also contributed to a retirement plan through their work during the year (even if a trivial amount) or were eligible for a pension, are allowed to take the deduction in full until they reach only $61,000 of income. Then the deduction starts to phase out and is completely phased out once they have $71,000 of income. For married couples filing jointly, the combined income (of both spouses) phase out range is only $98,000 to $118,000 when determining the deductibility of a contribution when both spouses participates in a work plan. In situations where one spouse participates in a work plan, and the other does not, the phaseout range for the deductibility of the contribution by the spouse that does not participate in a work plan is a combined income (of both spouses) of $181,000 – $191,000. If neither spouses participates in a work plan during the year, there is no income phase out for the deduction that year.

The other way people get basis in their IRAs is if they are inherited. Since IRAs do not get a step-up in basis upon the death of a decedent, you receive the basis the decedent had in the IRA (if any). So it becomes very important to make sure you know what this is and hopefully have some documentation supporting it.

When you start withdrawing money out of your IRAs, the tax preparer determines the tax free portion of your withdrawal by dividing your total historical IRA basis by the total year-end values of all your SEP, SIMPLE and Traditional IRAs and multiplying that ratio by your IRA withdrawal amount. If you or your past preparer(s) did not carefully track and pass this basis number on over the years, then your current preparer will generally assume there is no basis. As such you have just set yourself up to be double taxed – once when the money was put in and you did not get the deduction and now again, when you take the distributions.

Sadly, I regularly see new clients come through my doors whose basis is missing, drastically lower than it should be, or at least suspect of being low; the client often has no idea why it even matters, has not kept records, and has changed investment advisors and tax preparers several times. It becomes time consuming and expensive to recreate, if it can be done at all, or is even noticed in the first place. Unless a nondeductible contribution is made during the year, the Form 8606 used to track the nondeductible contributions, is not filed and therefore not part of the return you may hand to your new preparer. That individual has to have the presence of mind to ask about these carryovers. I see these problems mostly with do-it-yourself and discount tax service chains. Those options certainly have a right place and serve a need, but as a consumer, you need to understand the more you have at stake, the more detrimental is a mistake.

As mentioned before, with Roth IRAs, basis is created with every contribution. What becomes important to track with Roth IRAs is the total amount of direct contributions made to the Roth versus Roth conversions and rollovers from traditional IRAs. If you take any distributions before reaching age 59 1/2, or are over 59 1/2 but have had a Roth IRA for less than five years, these amounts become critical in order to calculate if a portion of your distribution is taxable. There is a specific ordering method for withdrawals which is favorable. As with traditional IRAs, Roth IRA basis is often forgotten about over the years.

The Form 8606 – Nondeductible IRAs does several things: 1) it is used to calculate and track nondeductible contributions to traditional IRAs, 2) it is used to calculate the taxability of SEP, SIMPLE, and traditional IRA distributions when there is basis, 3) it is used to calculate the tax on Roth conversions, and 4) it is used to calculate the any possible tax on Roth distributions. Part I of the is used for items 1) and 2) above. Part II of the form is used 3), above and part III of the form is used to calculate item 4).

The instructions to the form also explain how to handle recharacterizations – this is where you contribute money to an IRA and then later for that same tax year decide you want to “recharacterize” it as a contribution to a Roth IRA instead, or vice versa – it’s like a “do-over.” In addition the instructions explain how to handle excess contributions or a return of contributions made during the year.

Even though the taxing authorities have theoretically received all your 8606s since 1987 when nondeductible IRAs were first permitted, I have never seen them point out to a taxpayer that he had basis in the past that was overlooked. In fact, in the instructions to the form the IRS puts the burden on the taxpayer to retain the supporting documents from inception of your IRAs until your retirement accounts are fully distributed (plus at least three years for audit possibilities).

They ask that for the purpose of proving your basis in IRAs, you keep the first page of all 1040s, keep all Form 8606s, keep all Form 5498s from your custodian showing the amounts contributed each year, as well as all 1099-Rs showing any distributions. Now you know why, when people ask me how long I suggest keeping tax returns, I say, “Forever.” I actually have scans of every one of my personal tax returns dating back to when I was 16, mowing greens, raking bunkers, and driving tractors in the summer for a golf course.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

The official name for Form 5329 is “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” In other words, “penalties on incorrect contributions to or withdrawals out of retirement accounts, education accounts, and medical accounts.”

Most people are familiar with the fact that retirement accounts such as 401(k)s, 457 plans, IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs, etc. have limits on the amount of money you can contribute each year. They also limit your ability to withdraw money from those accounts until you are generally 59.5 years old, or meet one of a handful of limited exceptions.

Most people are also familiar with fact that you MUST begin taking distributions by the time you reach 70.5 years old (with a few exceptions such as for Roth IRAs, certain employees that have not yet retired from their job, or non-spouse inherited IRAs). You can delay the distribution in the year you turn 70.5 until April 1st of the following year, but if you do that, then you have to take two distributions that year. IRS instructions are often very poorly worded on this particular matter, and often people misunderstand this important point.

Education savings accounts such as 529 plans or Coverdell ESAs as well as tax favored medical spending accounts such as HSAs and Archer MSAs also have annual contribution limits. In addition, you must use the funds for qualified education or medical expenses, respectively.

If you fail to follow the rules, either by accident or out of necessity, you will generally incur penalties, which are calculated using Form 5329 for most of these infractions.

So, how much are the penalties? If you over-contribute to a retirement plan, education account, or medical spending account there is a six percent penalty on excess contributions if you do not withdraw the excess contribution (plus any related investment earnings) within six months of the original due date of the return, excluding extensions (so by October 15 for almost everybody). Any earnings generated by the over-contribution will be treated as distributions of cash to you in the tax year the correcting withdrawal actually occurs. The rules governing distributions (discussed later) will apply and you may be subject to penalties on that portion. The custodian of the account will calculate the related earnings that need to be pulled out of the account when you inform them of the need to withdraw funds.

If you over-contribute for multiple years in a row before realizing it, the penalty compounds. So you would file a Form 5329 for each of the past years (no 1040X needed) and pay six percent on the excess contributions for the year of the 5329 you are filing, plus any prior excess contributions that still had not been taken out. In other words, you pay six percent every year on the excess contribution until you take it out. Interest would also be assessed on top of the penalties.

If you fail to take a Required Minimum Distribution (RMD), the penalty is 50 percent of the amount that was supposed to be taken out, but was not. Unlike the six percent over-contribution penalty that applies every year until you take the funds out, the 50 percent penalty only applies once. But you would need to withdraw the funds and file a 5329 for each past year you failed to take an RMD. Interest would also be assessed on top of the penalties. Fortunately, the IRS has been pretty lenient with the steep 50 percent penalty, and you can often get them to waive the penalty for reasonable cause once you withdraw the money.

Early distributions for all retirement accounts that do not qualify for an exception are subject to a ten percent penalty, (plus inclusion as taxable income for the portion related to original contributions for which you received a tax deduction as well as on any earnings generated while in the account). SIMPLE IRAs have a special rule that increases the penalty to 25 percent if the date of your first contribution to the SIMPLE IRA was less than two years ago.

Distributions from education savings accounts for nonqualified purposes are subject to a ten percent penalty.

Distributions from medical spending accounts that are not used for qualified purposes are generally subject to a 20 percent penalty. These 20 percent penalties, however, are calculated on different forms (8889 for HSAs and 8853 for MSAs). With HSAs when you reach 65, you can use the money for whatever purpose you want, without penalty. You can also rollover an MSA into an HSA.

Regarding the Form 5329 itself, the first two parts deal with distribution penalties for retirement accounts and education accounts (health account distribution penalties are calculated on other forms). The third through seventh parts deal with excess contribution penalties for each different type of account. The final section, part VIII, deals with penalties on RMDs not distributed.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

At 7:50 am on July 3rd, I entered into my second contract of fatherhood! Fortunately it was not during tax season like my last contract when my son was born! No, I was all smiles when my daughter, Claire Elise Long was born in our home with the help of our wonderful midwife, Maggie Bennett, weighing in at around six pounds 14 ounces and 19 inches long.

Whereas the vast majority of children born on the Monterey Peninsula have a Monterey birth certificate due to CHOMP’s location, I think it is quite fun that my son has a Pacific Grove birth certificate and my daughter will have a Pebble Beach birth certificate. I told my wife, Joy, that we need to move and have children in Seaside, Sand City, Del Rey Oaks, Carmel, and Marina so we can collect all of the more rare birth certificates. She did not find that as amusing as I did.

I think Claire Elise may be a Daddy’s girl as she followed through on my in-womb negotiations with her about the timing of her birth…unlike her brother, Elijah, who came during tax season despite express language in his birth contract stating otherwise. Claire Elise upheld the terms of not exceeding seven pounds eight ounces (a point bargained for by her mother) and she was given a right to exercise her birth option from June 29th to July 31 with a birthing bonus if born on July 4th.

When negotiating pressures intensified in the early hours of July 3rd, Joy caved and was very easy to persuade and saw no further need to hold out until the 4th. I, however, needed more convincing. Claire Elise deftly pointed out that being born exactly on the first day of the 10th fiscal quarter after her brother was born, would simplify things for quarterly reporting purposes…she knew how to push my buttons.

After holding the beautiful bundle of love, we immediately decided to approve her initial contract for child-rearing. When my son was born we struck a deal with him to extend his initial contract through kindergarten with two renewable six-year options.

The second renewable option would include an opt-out for us after the middle school years. There would be some additional language which could allow for a third six-year option to get through the college phase depending on certain performance benchmarks achieved in the prior option period.

Based on our experience with our son, we decided to offer similar terms but with some additional specific language regarding liquidated damages for things like unprovoked dumping of milk and juice and other gravitational experiments with glassware and plates, storing the remote control in a cup of chocolate milk, and breaking necklaces and expensive pairs of eyeglasses.

With business out of the way, we have been having the time of our lives…again! The precious little noises and movements, the intoxicating cuteness, and her absolute and impartial trust make life a true blessing. As I hold her in my arms, I know there is much good to come. I can now look forward to not only experiencing the unique joys of having a son, but also the equally unique joys of having a daughter – and for this, I am very grateful. I love you, Claire Elise; you make Daddy very proud!

Next step…convincing Momma that baby-modeling is a good idea so Claire Elise can generate earned income and open a Roth IRA!

President Barack Obama announced in his State of the Union Address at the end of January, the formation of a new retirement plan option which will likely get started towards the end of 2014. The account type, dubbed “myRA” (pronounced “My R.A.”) is short for “My Retirement Account.” Despite a plethora of retirement plan options already available, one might ask, do we need yet another option to complicate planning? Despite all of the options available, roughly one third of employees in the United States still do not contribute to any type of retirement plan. Another third participates in an employer sponsored plan, and roughly the other third has an employer sponsored plan and some type of IRA as well. In a survey conducted by the Employee Benefit Research Institute, 57 percent of Americans say they have less than $25,000 in total savings (excluding the value of their house or defined benefit plans).

The point of the myRA is to help make it more accessible for the bottom third of savers to work on saving for retirement. My analysis is that in its current form, it may mildly assist in this manner, but could be used by more savvy investors as a way to access, to a limited extent, the G-Fund, a solid short-term investment option only available to people with government sponsored TSP programs.

The problem with myRAs is that they do not automatically enroll employees upon initial employment. This has been a desire of the President, but would require Congressional action. The goal of automatic enrollment would be to make it the default option, unless the employee deliberately opts out of the program. Without automatic enrollment there is very little reason to believe employees would be more likely to join these plans than ones already offered by employers. That said, many small employers currently do not offer plans to employees due to the added expense of operating and/or contributing to the plan, and most of them exclude a lot of short-term or part-time employees.

The myRA would have a very low entry point – with only a $25 opening contribution by an employee, no fees or requirements for the employer to contribute, and a $5 per paycheck minimum contribution, it is theoretically much more accessible, especially for short-term and part-time employees. The plan would also be portable from one employer to the next, helping to reduce “retirement plan trinkets” – my term when people carry around a half dozen retirement plans from all their former employers. The program would be administered by the federal government, and since it would have only one investment option, there should be a lot less questions and hassles to set up. The employer would simply direct a portion of the employee’s direct deposit to the government, instead of the employee’s bank account.

The lone investment option is the Thrift Savings Plan offered G-Fund – Government Securities Investment Fund. This fund invests in United States government securities and its goal is to outstrip inflation but is also guaranteed by the full faith and credit of the United States government. Its guaranteed return is the weighted average of all outstanding Treasury notes and bonds with a four year or longer maturity. So effectively you get a long-term rate, even though your investment could be short-term. Since 1987 its average return has been 5.4 percent per year. In 2013 it returned 1.89 percent – not fantastic, but much better than most short-term investments available today, and with no risk.

One of the key characteristics of a myRA is that it is effectively a Roth IRA. This means you get no tax benefit for putting money into the account, but it grows tax-free forever, has no required minimum distribution when you turn 70 1/2, and there is no tax on the principal or earnings when you withdraw it in retirement. Like a Roth IRA, f you need to take money out sooner, you can take out your original contributions with no penalties (but not earnings). The same income phaseouts for Roths apply to myRAs as well – you must have adjusted gross income less than $129,000 filing Single, and $191,000 Married Filing Joint ton contribute. In addition, the same aggregate IRA contribution limits ($5,500 for people under 50 and $6,500 for people over 50) will apply for all IRAs, including your myRA.

A key provision with a myRA is that once the account balance hits $15,000 (or 30 years) it is automatically converted to a regular Roth IRA. However, people can rollover funds from a myRA to a regular Roth IRA at any time to keep their balance below $15,000. I could see this used by people who like access to the G-Fund as a safe, possibly, short-term investment that provides a decent rate of return.

Personally, I think we need to consolidate and simply our retirement plan options, and not create more animals to supervise. But for now, the tax code continues to grow more complex – benefitting some, and making things more confusing for most.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

At 10:16 am on April 3rd, I entered fatherhood! Needless to say, this has made the most interesting end to a tax season for me so far! Elijah Bennett Long was born at our home weighing in at seven pounds four ounces and 20 inches long. Personally, I think it is quite neat that he will have a Pacific Grove birth certificate – not too many of those around!

I was negotiating with him while he was in the womb for the past few months and explaining why it would not be wise to renege on his contract date of April 21st. He brought up several valid points: 1) he was not the proximate cause of this event 2) there were early escape clauses in his contract, and 3) interested parties (Joy – Momma) would prefer to have him at seven pounds four ounces rather than closer to nine pounds! I admit, the kid had some good points.

Despite his exercising the early exit-strategy rights on the development phase, we have decided to approve his initial contract for child-rearing. We are thinking to have this contract extend through kindergarten with two renewable six-year options. The second renewable option would include an opt-out for us after the middle school years. There would be some additional language which could allow for a third six-year option to get through the college phase depending on certain performance benchmarks achieved in the prior option period.

With business out of the way, we have been having the time of our lives! How fun it is to come home and see that tiny bundle of love. It actually has worked out quite well these past few weeks as tax season has come to a close. I was working late hours anyway which made it perfect to help out with some of the night duties since I was still wide awake! What a blessing!

Next step…convincing Momma that baby-modeling is a good idea so he can generate earned income and open a Roth IRA!

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

A lot of people like the idea of contributing to a retirement plan, but do not like the idea of locking up the money until retirement without being penalized. People are often concerned about supplementing income if they lose their job, or have an unexpected major expense, or even if they are saving for a big purchase such as a car or a home. If you find yourself keeping money in a taxable investment account, savings, or checking account for these purposes, I strongly encourage you to start contributing it to a Roth IRA if you are eligible.

The beauty of a Roth IRA is that you can take out your direct contributions tax-free and penalty-free at any point. For example, if you contribute $5,000 a year for three years, you can always take out up to that $15,000 at any point. What you cannot take out are the earnings. If it grows to $16,000 through interest, dividends, or appreciation, you cannot take out that last $1,000 without penalty and tax until you retire. The big benefit is that your Roth IRA is an umbrella that protects the assets under it from being taxed if they generate income. You will pay no tax on the $1,000 earnings in the Roth IRA – whereas, you would if it was held in a taxable account. You can hold almost any investment in a Roth-IRA including cash, stocks, bonds, mutual funds, or even alternative investments such as rental property. You can currently contribute up to $5,000 a year ($6,000 over age 50) and you have until April 17, 2012 to contribute for tax year 2011. Don’t miss out!

Some advisors incorrectly cite a five-year rule that says you have to have the account open for five years before taking penalty-free withdrawals. This applies in certain circumstances, but not to direct contributions. What they are failing to understand are the ordering rules for distributions. I will say again, you can always take out up to the sum-total of your direct contributions made to the account with no tax and no penalty. Be aware that rollover conversions from other retirement plans and traditional IRAs are not considered direct contributions. You should get competent tax advice if you are going to take out beyond your direct contribution total.

To be eligible to make a Roth IRA contribution, you must have at least as much earned compensation as you want to contribute. If you file jointly, you can contribute for your spouse even if he/she does not work enough (or at all) assuming you earn enough compensation between the two of you. Your ability to contribute starts phasing out as your income hits $107,000 if filing single, and $169,000 for married filing jointly. These amounts are based on special modifications to your adjusted gross income, so you would want to verify with your tax professional if you are close to these thresholds. You can also contribute to a Roth IRA even if you contribute to an employer-provided plan (some exceptions for married filing separate), however, your contributions to traditional IRAs and Roth IRAs are aggregated for contribution limit purposes.

One other advantage of the Roth is that you can continue to contribute during your entire life as long as you have earned compensation, and there are no required minimum distributions when you reach age 70 1/2 as there are for traditional IRAs.

What you might find by contributing, is that something else works out in your financial life whereby you do not end up needing that cash or part of it after all, and at that point, you will be very glad you contributed to the Roth during those years. To set up a Roth IRA, talk to your financial advisor. If you do not have an advisor, you can go online to a financial institution like Vanguard or Fidelity and set one up in 15 minutes.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Well, not me, technically, but my wife is. After 12 years of wedded bliss, we are entering the baby business. Like most future parents we are excited, but being a CPA takes it to a whole new level of joy! There are so many planning opportunities around children.

Planning can start well before birth or even years before conception. For example, the highly tax savvy high school senior could think, “Someday, I am going to have a family of my own. Knowing the high cost of college I am about to incur, I should really start saving for my future child’s education now to maximize tax-deferred growth! That raucous week in Cancun is really a waste of money, anyway.” Instead this high schooler opens a section 529 plan and names his older sister’s child as a beneficiary. After four years in a frat house, a year traveling after school, a few years bouncing around finding himself, falling in love, getting married, and finally having a child, this new parent then renames the beneficiary to his own child with a ten-year jump start on tax deferred education saving!

What about the expense of having the child? This natural process which has gone on quite successfully for a few million years or so at no cost, mostly outdoors in the dirt, can now be quite pricey, and sterile. It may cost $5,000 if you use a midwife or $25,000 in a hospital! You will likely go over your deductible and insurance will pick up the rest. A great option is to have a high deductible health plan going forward with a health savings account. This setup makes virtually all of your family medical expenses deductible whereas people with traditional plans are stuck itemizing with a 7.5 percent of AGI floor – meaning most people do not get any tax benefit. It also allows the deductibility of more types of expenses and alternative care.

Next, there is the additional exemption deduction to get excited about – we are talking $3,700! You are also eligible for child tax credits – up to a $1,000 per child. And if you are low income, the child may help qualify you for a larger earned income credit: up to $3,094 with one child or $5,751 with three or more! Child tax credits and earned income credits can be refundable – meaning, even if you do not pay a dime in tax, the federal government will “refund” the money to you anyway – but having children is not a great way to get rich. For advanced tax planning, you aim to have your child near the end of December and still receive the exemption and credits for the whole year. No expense, but full benefit – brilliant!

Do not forget about dependent care credits and education credits either. Dependent care credits will save you up to $1,050 for one child or $2,100 for two or more children. Education credits for college age children such as the Hope credit can save you up to $2,500 in tax.

My favorite planning opportunity which I have yet to implement with a client is baby modeling. If you can get your baby into print or TV commercials, then I feel you would have a strong case to say the baby has earned income. Maybe the “talent’s” agent, a.k.a. mom or dad, would need to be paid out a heavy agent fee since it really required a lot of work on their part – but then again, I am sure that many famous actors and actresses have to be babied by their agents too! Once your baby has earned income, you can establish a Roth-IRA for retirement! Think about 18-22 years of additional investment compounding! (Call me if you have a child in this situation – I want to put this in action!!)

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

The stock market seems like a pinball these days bumping off financial forecasts and being paddled by fiscal policy promises. Unable to stomach some of the lows over the past few years more than a few people gave up the game and pulled money out of investments seeking the “security” of cash. Others may have felt they had no choice, and cashed out their retirement savings to live on; some realizing they contributed more money to the plan than they got back! Perhaps this happened to your retirement or education savings accounts, or will happen at some point. But can you get a tax deduction for the loss in value you have incurred?

Well, it depends. The chief determining factor is whether or not you have basis in your account. Basis in a retirement or education account is created if you make contributions for which you receive no tax deduction when contributed. For example – Roth-IRA contributions are not deductible when they are made, so the original contribution amount each year adds to your basis. Education savings through section 529 plans and Coverdell Education Savings Accounts are the same way. Many employers now offer a Roth contribution option within a 401(k) plan. These contributions also create basis.

Traditional 401(k), SEP IRAs, SIMPLE IRAs, and traditional IRA contributions provide you with an immediate tax deduction, so they provide no basis. However, if you were over a certain income threshold and tried to make traditional IRA contributions, you may have been allowed to contribute to the account, but prohibited from taking the deduction. This is termed a “nondeductible IRA contribution;” it would have created basis; and it is tracked on Form 8606 in your tax returns.

If it is determined you do have basis, and for a strategic reason (or by necessity) you end up liquidating the IRA (all IRAs of the same type must be liquidated for this to work), and the value of the IRA is less than your basis in the account, then you are eligible to take the loss as a miscellaneous itemized deduction subject to the two percent threshold. If you have more than one section 529 plan, the calculation is a little different.

Liquidating your retirement accounts to get a possible tax deduction is not typically an advisable course of action for many reasons, and you would want to discuss this with your tax professional and investment advisor first. However, sometimes, this can be a strategic move. More often, it will have been done out of perceived necessity or by accident. If it happens, however, you certainly want to make your tax professional aware of your losses and take the deduction if you are eligible.

Two quick examples: 1) Melissa, a parent, starts a 529 account (only has one) and contributes $10,000 towards her child’s future education. A year later, the investments have fallen, and the account is only worth $6,000. Melissa could liquidate the account and take a $4,000 loss on Schedule A. Then she could start a new 529 plan putting the $6,000 back into the plan. Melissa has just harvested a $4,000 loss. 2) Joseph opened his first Roth-IRA three years ago and contributed $14,000 over the three years. He received some bum advice from a friend and invested most of it in a penny stock mail-order belly-dancer business that went belly-up. Joseph’s account is now only worth $1,000. He could liquidate his Roth-IRA and take a $13,000 loss on Schedule A.

There may be other circumstances and specific rules that affect you, and you should consult with a qualified tax professional regarding your tax situation. Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950. He can be reached at 831-333-1041.